Understanding Funds Transfer Pricing

This chapter discusses:

• PeopleSoft Funds Transfer Pricing.

• PeopleSoft Funds Transfer Features.

• Matched maturity marginal funds transfer pricing.

• Integration with PeopleSoft Enterprise Performance Management warehouses.

PeopleSoft Funds Transfer Pricing

This section discusses:

• Types of funds transfers.

• Cost-of-funds curves.

• Use of funds transfer prices.

Organizations use a cost-of-funds rate to determine whether the yield on a loan meets profit targets after covering not only the credit risk and operating cost associated with the loan but also an appropriate funding cost for the loan. Similarly, organizations assign a funding credit to deposits to measure the deposits' net value after taking into account the associated costs. You can use Funds Transfer Pricing to assign an economically appropriate charge or credit for funds for each asset and liability on your balance sheet. Assigning these charges and credits provides two benefits:

• You transfer the interest rate risk of a funding position to the treasury unit where it belongs.

• You provide a value-added incentive structure for the line managers.

Types of Funds Transfers

You can price the following types of funds transfers:

• Ledger balances

  You can use funds transfer pricing for balance sheet accounts where the ledger account is the lowest level of detail or where a single transfer price per ledger account is sufficient. For example, you can calculate the funds transfer price and assign it at the ledger-balance level for fixed assets (such as building and equipment), general accounts (such as cash accounts and prepaid expenses), equity accounts, and indeterminate maturity liability accounts (such as deposit and savings accounts).

• Product balances

  You can use funds transfer pricing when transfer price calculations are based on an individual instrument's financial characteristics, such as repricing period, current balances, remaining term to maturity, payment schedules, rate change schedules, projected cash flows, and behavioral (rate sensitivity) models. PeopleSoft Funds Transfer Pricing analyzes these variables to determine the expected tenor (or term) of the instrument. The funds transfer price is then calculated by matching the tenor of the instrument to the yield curve (market rate) of the same maturity.

• Treasury position balances

  You can use funds transfer pricing for summary-level net positions for foreign exchange or other trading-room positions.

• Forecasted pools

  The forecasting process can create forecasted pools for which you can calculate funds transfer pricing charges and credits.

Regardless of the data source that you use to calculate the funds transfer rates and amounts, you may want to ensure that all accounts on the balance sheet are transfer-priced. To this end, PeopleSoft Funds Transfer Pricing includes a reconciliation function that enables you to reconcile instrument balances and treasury position balances to ledger balances in PeopleSoft Financial Management Solutions.

Cost-of-Funds Curves

The funds transfer rate is based on a cost-of-funds curve, which is derived from market rates (yield curves) for products with similar financial characteristics.

The cost of funds curve that you define for a bank or operating unit should be representative of the opportunity cost of funds. Such as, how much the institution would pay for the required funding or how much the institution would receive from excess invested funding at the margin. You may want to set up a cost-of-funds curve that is currency-specific, because interest rate curves vary across currencies.

Typically, the funding center is an asset and liability management unit or treasury department that funds the asset or invests the proceeds of the liability.

Use of Funds Transfer Prices

The funds transfer price is a standard for the buying and selling of funds among business units. You can also use it to measure the profit contribution of each asset and liability or business unit. The funds transfer price is an interest rate representing the value of funds to an institution. It is typically based on current market interest rates adjusted for risk and cost variables that are specific to the institution.

By assigning a transfer price to each component on the balance sheet, you can compare the earnings that result from the use of each asset with alternative uses. In addition, you can compare the cost of each source of funds to alternative sources, and you can measure the profit contribution of each asset or liability.

For example, suppose that you want to measure the monthly profit margin on a mortgage loan with a balance of 100,000.00 USD and an interest rate of 8.5 percent. Here are the amounts:

Interest income = 708 USD (100,000 × .085 × 1/12)

funds transfer pricing base charge = 525 USD (matched maturity marginal cost of funds)

funds transfer pricing adjustment = 25 USD (cost of payoff option on the loan)

Spread = 158 USD

Net interest margin = 1.896% (158 × (12/1) / 100,000)

PeopleSoft Funds Transfer Features

With Funds Transfer Pricing you can:

• Calculate a funds transfer pricing base rate:

  • For new instruments.

  • For instruments that are extended or renewed, using a blend of the old rate and the current interest rates charged for these types of products.

  • At the repricing anniversary for variable rate loans.

  • At the end of the reporting period for all instruments whose funds transfer pricing rate is reset each reporting period.

  • When funds transfer pricing repricing events are triggered by an external system.

• Calculate transfer prices on ledger account balances on detailed instrument balances, or on treasury position balances.

• Choose from among several methodologies to derive the maturity when calculating funds transfer pricing rates based on matched maturity funding:

  • Strip funding

    This approach matches the projected cash for the instrument in each time period, with a specific cost of funds rate for that cash flow. The funds transfer pricing rate for the instrument is then calculated by weighting the cost of funds rate for the cash flow in each time period by the term of the cash flow.

  • Duration matching

    This approach calculates the maturity of a pool of instruments. It uses the standard algorithms for calculating the cash flow duration, modified duration, or effective duration of the projected cash flows. The duration measure that you select is then used as the term for matching the maturity of the instruments. Duration matching is particularly effective when transfer pricing pools of relatively homogeneous instruments.

  • Average life

    This approach calculates the effective term of an amortizing product. Average life is the period of time required for one half of the principal balance to be repaid based on projected cash flows.

  • Repricing frequency

    For variable rate products, the primary interest rate exposure when funding instruments is limited to the length of time it takes for the instrument to reprice—that is, the interest rate is adjusted to current market rates. For these products, you can match the term used to calculate the funds transfer pricing rate to the repricing period of the underlying instrument. The funds transfer pricing system automatically resets the funds transfer pricing rate at the same time intervals and uses the same term as the instrument’s repricing schedule. The repricing period can be set based on a periodic repricing frequency or specific scheduled repricing dates.

• Transfer price based on user-defined term or rates.

  In addition to using one of several matched maturity concepts, Funds Transfer Pricing gives you the flexibility to specify terms or rates to be used for transfer pricing. You can use the contractual term to maturity, an arbitrary term that is user-defined, or a specific funds transfer pricing cost of funds rate to be used for a set of instruments or ledger accounts.

• Use option adjusted costs and option adjusted spreads to calculate transfer prices.

  This enables you to accurately price the volatility of financial products with embedded options, such as prepayment options on loans.

• Transfer price instruments originated with intent to sell by applying a term based on their expected holding period.

• Model durations for asset and liability products of indeterminate maturity (such as demand deposits, savings, NOW accounts, equity lines, bank cards) and balance sheet accounts (such as receivables, float and reserves, fixed assets, payables, equity) for more accurate transfer pricing.

• Apply any number of adjustments to the basic funds transfer pricing rate.

  For example, you can apply adjustments for liquidity, embedded options, or incentives to the line managers. The adjustments can be a fixed rate, or a fixed amount, and are calculated separately from the base funds transfer pricing rate, so they can be easily identified and reported. You can also apply event-based funds transfer pricing adjustments—that is, define a funds transfer pricing adjustment rule that is only applied if a constraint is satisfied.

• Apply a funds transfer pricing adjustment for commitment period rate lock options that enable the customer to receive the minimum interest rate available during a commitment period.

  The commitment period rate lock adjustment is calculated as the difference between the minimum posted rates available during the commitment period, and the actual rate that was in effect on the start date.

• Calculate the cost of allocated capital using the cost of funds rate for equity.

  The cost of capital can be calculated and reported separately from the funding costs of an instrument or ledger account balance.

• Use the Stratification Engine to group millions of individual instruments with the same financial characteristics into a much smaller number of instrument pools.

  This dramatically improves the processing time for calculating the funds transfer pricing rates. It also enables you to use advanced analytics and modeling techniques to calculate the effective maturity of a large number of instruments within acceptable processing time windows.

• Perform multiple modeling (what-if analyses), for example using behavioral models (interest rate sensitivity) or product pricing models.

• Apply break fund charges for loans that prepay, as well as for cancelled commitments.

  Apply a onetime break fund assessment or accrue break fund charges over the term of the loan. Allow the user to define the amortization period for the break fund charges.

• Reset the funds transfer pricing rule, funds transfer pricing base rate and funds transfer pricing adjustments for existing instruments whose cash flow characteristics have changed—for example, when a loan converts from a variable to a fixed rate loan.

• Transfer price forward commitments.

  These are typically large, fixed rate commercial credits that are usually match funded (guaranteed rates) prior to the booking of the transaction. Because of their size, these loans are literally matched at the margin, and the rate is locked in during negotiations. These transactions are therefore funded and transfer priced as of their commitment date, using a forward rate curve.

• Calculate transfer prices for forecasted balances.

  You can calculate funds transfer pricing charges and credits for forecasted balances during planning and simulation runs.

• Segment transfer pricing balances and apply different transfer price rates based on varying volatilities.

  Use balance segmentation for indeterminate maturity balances, such as checking accounts, accounts receivable, credit card balances. The core portion of savings accounts may be considered stable, with an funds transfer pricing rate based on a medium or long term cost of funds, while the remaining portion is considered volatile, with an funds transfer pricing rate based on a shorter term cost of funds.

• Use effective dating for assumptions, which provides you with a history of assumptions to help you track rules and make inquiries concerning results.

• Assign transfer pricing rules based on account tree nodes.

  For example, if the other assets node included multiple ledger accounts, you could choose to apply a funds transfer pricing rule to the tree node that represents all other assets, rather than to each ledger account individually.

• Perform multiple dimensional analyses of profitability.

  For example, you can use Funds Transfer Pricing to evaluate product profitability for each customer segment, thereby providing insights into bundling strategies and loss leadership relationships.

Matched Maturity Marginal Funds Transfer Pricing

PeopleSoft Enterprise Funds Transfer Pricing supports the matched maturity marginal funds transfer pricing methodology, which is based on the concept that a centralized unit, the treasury, serves as a conduit for all of the institution’s funds using current market marginal funds costs. Under this system, each business unit sells its liabilities at appropriate transfer prices to the treasury, and each business unit buys the funds required to support its assets at appropriate transfer prices from the treasury. In effect, each business unit is treated like a fully matched book: assets receive a transfer price charge that reflects their maturity and liquidity characteristics (cash flows, repricing, origination date, maturity), while liabilities receive a transfer price credit that reflects the market value of funds with those same characteristics.

One of the primary benefits of this methodology is that each component of the net interest margin can be measured independently:

• Asset or lending spread is the difference between the actual yield on assets and their matched cost for purchased funds from the treasury.

  This spread measures the economic return on assets, independent of actual funding sources.

• Liability or funding spread is the difference between the actual cost of deposits and the credit for sale of funds to the treasury.

  This spread measures the opportunity value of deposit funds independent of their use.

To illustrate, assume that the bank has issued a short-term time deposit costing 7% and funded a long term loan yielding 12%. The deposit costs 100 basis points (bps) less than purchased funds with a similar maturity, and the loan has a yield 200 bps higher than the bank would pay for funds of the same maturity. This graphic illustrates the margin components:

Funds Transfer Pricing Margin Components

The end result is that the spreads reported on assets and liabilities are more stable, reflecting the true economic contributions of these products, while the income variability resulting from changing interest rates is isolated in the treasury, where it can be best managed on a consolidated basis.

Integration with PeopleSoft Enterprise Performance Management Warehouses

PeopleSoft Enterprise Funds Transfer Pricing draws data from PeopleSoft Enterprise Performance Management warehouses for its processing, and posts results back to the warehouse for reporting. After you load the data from your source systems into the Operational Warehouse Store (OWS), the Extract, Transform, and Load (ETL) process moves it into the Operational Warehouse (OWE). You can run another set of ETL maps to populate the Multidimensional Warehouse (MDW) tables, which are used by Business Intelligence reporting tools to create reports.

See Understanding Common PeopleSoft Financial Services Industry Processes.

Funds Transfer Pricing Engine Output Tables

The following are output tables specific to PeopleSoft Funds Transfer Pricing processing:

• FTP_RECALC_R00: Stores the components of the funds transfer pricing recalibrated rate.

• FTP_RECALC_TBL: Stores the components of the cash flows used in the calculation of the funds transfer pricing recalibrated rate.

• FTP_FCST_F00: Stores funds transfer pricing charges per accounting period for forecasted pools output.

• FI_FCSTRATE_R00: Stores the funds transfer pricing rate for historical and forecast instruments/pools.

• FI_IFTPRATE_R00: Stores funds transfer pricing rates for instruments.

• FI_IFTPADJ_R00: Stores funds transfer pricing adjustments.

• FI_IBFCHRG_R00: Stores break fund charges output from the FTP_BFND application engine .

• FI_IFTPBFND_R00: Stores break fund rules.

• FTP_CALC_IN_F00: Stores funds transfer pricing charge or credit amounts for instruments output from the FTP_INST application engine.

• FTP_CALC_AC_F00: Stores funds transfer pricing charge or credit amounts for PF ledger accounts output from the FTP_ACCT application engine.

• FTP_CALC_PS_F00: Stores funds transfer pricing charge or credit amounts for treasury positions output from the FTP_TRPS application engine.

• FTP_CALC_IP_F00: Stores funds transfer pricing charge or credit amounts for forecasted instrument pools output from the FTP_FPOOL application engine.

• FI_POOLFTP_R00: Stores funds transfer pricing rates for forecasted instrument pools.

• FTP_CCRATE_F00: Stores current period cost of capital rates to be used when calculating funds transfer pricing charges for RWC allocations for an instrument, account, or position.

• FTP_RCN_F00: Stores funds transfer pricing charges or credits for reconciliation amounts, (differences between product or PF Ledger balances and position or PF Ledger balances).

• FTP_CALC_BL_F00: Stores funds transfer pricing charge or credit amounts per Accounting Period for Financial Instruments output from the FTP_INST application engine.